The eurozone economy is at risk of “Japanification”, a cycle of low growth and spiralling debt levels that could trigger a series of government bond downgrades, Fitch Ratings has warned.
In a report published on Friday, the rating agency said the euro area’s weak growth and low inflation suggested the currency bloc could follow the deflationary path trodden by Japan since the early 1990s. According to Fitch’s analysis, the risks are most acute in Greece, Italy and Portugal.
Fears of Japanification swept through Europe’s markets this summer. Government bond yields fell to record lows as investors bet the malaise would last for years. Although yields have since risen somewhat, they remain below zero for many eurozone members, suggesting investors believe a return of growth or inflation, or a rise in interest rates, remains remote.
Ed Parker, head of European sovereign ratings at Fitch, said the euro area’s recent record of “lacklustre growth”, low inflation and negative interest rates — and the European Central Bank’s difficulty in exiting its vast bond-buying programme — had parallels with Japan.
“An ageing demographic profile and the origin of the economic weakness in the global financial and eurozone crises, which were preceded by credit and asset price bubbles and left a legacy of weak banks, add to the similarities.”
Unlike Japan, the eurozone has not experienced outright deflation, he added. If it does occur it would “materially worsen public-sector balance sheets” and open the door to “extreme downside scenarios”.
Japan’s government debt level has ballooned over the past three decades, rising from 65 per cent of gross domestic product at the end of 1991 to 233 per cent at the end of last year. Fitch stripped the country of its triple A rating in 1998, and now rates Japan five notches below at A.
Despite having the highest public debt in the world, Japanese yields have stayed very low, largely thanks to huge bond purchases by the Bank of Japan.
According to the Fitch analysis, the widely varying performance of the eurozone’s 19 economies would complicate the policy response to a scenario of full-blown Japanification. For example, the ECB would struggle to match the scale of the BoJ’s intervention in markets, due to the political difficulty of lifting the 33 per cent limit on how much of any country’s debt it can buy.
“Differences within the eurozone, fiscal and monetary policy constraints, and strains on political cohesion would make it difficult for the eurozone to escape Japanification, if it were to take root,” Mr Parker said.